ITS 4450 - Fraud Risk Assessment Tools and Investigation


Chapter 12, Revenue- and Inventory-Related Financial Statement Frauds

This lesson presents material from chapter 12. Objectives important to this lesson:

  1. Revenue-related fraud schemes
  2. Inventory-related fraud schemes
Concepts:
Chapter 12

This chapter, like the last one, is about fraud that is committed by the executives of a company. The chapter begins with an discussion that hinges on the fact that recording and reporting revenue is not as easy as it sounds. We are given several examples of businesses that might record revenue at times earlier than when a product is sold. For example, a drilling or mining company might need to show potential revenue when the raw material is found, as opposed to when it is sold to a distributor or user. Why do we care? Because it is always correct to use Generally Accepted Accounting Principles, but it is necessary to know which ones to use for a particular business, situation, or transaction. Intentionally using the wrong ones takes us into the commission of a fraud.

Improper reporting of revenue portrays the company as more prosperous than it actually is. On page 410, the text tells us a story about a Regional Bell Operating Company called Quest. Its reports of revenue, in the time period in question, portrayed them as having twice the revenue they actually had. The text becomes a bit hard to follow, but the main idea is that the responsible executive at Quest who filed those reports were indited for committing fraud. The text presents a list of methods that have been used to commit revenue fraud on page 411. Most relate to overstating income, reporting income that has not been received yet, and selling assets to a company that sells them back to you. The list of fraud methods on page 412 lays out methods to exploit a half dozen kinds of opportunities.

The text presents a list of six symptom types that apply to all frauds. We have seen this list before. This time the author presents a list of examples of each type that relate to revenue fraud, beginning on page 413. We will discuss some of these in class.

The chapter continues with advice on spotting symptoms of fraud in revenue statements. The bottom line, as always, is to find a lie. Where do the numbers make sense, and where do they not? Of course, there are ways to tell the truth that are more beneficial to the filer. These are not lies, they are carefully prepared statements of facts.


The discussion of inventory fraud is more enlightening. On page 422, the text explains that overstating Inventory makes it look like you sold fewer items, which means that your Cost of Goods Sold will be understated. That cost is subtracted from Sales to calculate Gross Margin, which is then overstated. Expenses are subtracted from the overstated Gross Margin to get Net Income, which will also be overstated. Bottom line: the company looks like it is more profitable than it really is. The good news is that when the company lies about inventory, the lie can be proven by a reliable check of the location where the inventory is supposed to be. Unless the site is burned to ashes, or the goods are lost at sea on a leaky freighter, or Commissioner Gordon, the entire contents of the warehouse have been stolen! Something must be done!


I have another video to play for you at this time. Let's see if it runs in the classroom. The lesson becomes more of a warning. You really need to understand accounting to do this kind of investigation. If you don't know the subject, you need to hire an expert who can be trusted.




Assignments

  1. Continue the reading assignments for the course.
  2. Complete the assignments and class discussion made in this module.